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A fairly typical pension plan for a public school teacher in California is as follows – if they retire at age 55, they receive 1.4% of the average of what they were paid during their three consecutive years of highest pay. If they retire at are 60, the multiplier increases to 2.0%, and if they retire at age 63, it will be 2.4%. Also fairly typical are the following rates of contribution into the pension fund – the employee contributes 8.0% in the form of payroll withholding, and the employer contributes an additional 8.25%. This post is to examine what rate of return on the pension fund is necessary in order to maintain solvency under these terms.

If you check the Actuarial Life Table courtesy of the U.S. Social Security Administration, you will see that the average 63 year old American male has a life expectancy of another 18 years, and the average American female at age 63 has a life expectancy of 21 years. To be conservative, assume the pension fund will need to retain a positive balance for 18 years after retirement – taking the average would require a higher rate of return, but in the interests of always using conservative assumptions, we’ll go with 18 years.

Following this text are three tables that show the results of a baseline case and two what-ifs. In the baseline case, the teacher commences work at age 26, works for 38 years, then enjoys 18 years of […] Read More